Fed Economists: Weigh ‘Good News’ in Eminent Domain Debate

Federal Reserve economists Wednesday stepped into the thorny debate over the potential use of eminent domain to fix the nation’s underwater mortgage problem, choosing to highlight housing-market improvements that could influence views on such a measure.

Economists from the New York and Boston Fed banks found that many homeowners in San Bernardino County in California, a hard-hit area that considered using eminent domain, have benefited from other forms of help that reduced the burden they have endured since the financial crisis and recession sacked the value of homes in the area.

The economists referenced a program that would help municipalities take underwater mortgages out of Wall Street-issued bonds by invoking eminent domain, and restructure the loans by cutting balances to match current housing values.

Bond contracts often prevent lenders from cutting principal, a measure that eminent domain advocate Mortgage Resolution Partners says is the best way to free homeowners of the loan burden and spark lasting recoveries in real estate and consumer spending.

But MRP has encountered stiff resistance from bank and securitization groups that say that eminent domain would unfairly saddle bond investors with losses and hand profits to MRP and its investors. Critics also charge using eminent domain would chill future lending by banks afraid that their loans could be seized.

While nodding to the lingering scourge of underwater loans in San Bernardino County, the economists said that “good news”–including rising home prices and lower monthly payments that have come on the back of falling interest rates–must play a role as cities decide whether the benefits of the controversial eminent domain plan are worth the costs.

Nearly 70% of San Bernardino borrowers with adjustable-rate loans and 30% with fixed-rate loans have seen payments fall since 2007, they said.

In San Bernardino, “while a large fraction of borrowers remain dramatically underwater, a number of life rafts in the form of low interest rates, loan modifications, and recently increasing house prices have kept many from drowning,” the economists said.

An authority formed by San Bernardino County and county cities Ontario and Fontana rejected the eminent domain proposal last month, though MRP is still discussing its plan with many other U.S. cities.

Robert Hockett, a Cornell University law professor who helped develop MRP’s plan, said municipalities must consider cautionary notes, too. Despite home price gains, some analysts see another “significant retreat,” he said. That many analysts see principal reductions as the most effective way to stop foreclosure must also be factored into the cost-benefit analysis of eminent domain, he said.

As there is broad agreement that mortgage debt is a drag on the economic recovery, principal reduction “would seem to be better” as a solution than interest-rate reductions, he added.

The comments posted on the New York Fed’s website by economists Andreas Fuster of the New York Fed, Paul Willen of the Boston Fed and New York Fed analyst Caitlin Gorback, noted that the number of private mortgages eligible for such a program in San Bernardino County is relatively small. Only 15% of the 456,000 mortgages haven’t yet been refinanced or already entered foreclosure, they found.

They also said the delinquency rate on loans has decreased, even as the hazards of long-term delinquencies remain high.